Why Does Cash Flow Out Faster Than It Comes In? Bookkeeping Basics You Need to Know

TLDR included <3

If you haven’t got a clue why money keeps coming in but seems to leave just as fast, it’s probably because you’re not doing your books—or at least not keeping up with them. Here are some bookkeeping basics you need to know to start managing your cash flow effectively.

If this is too long scroll to the end for a quick summary with actionable tips.

Accounts Receivable (A/R): The Money You’re Expecting

Accounts receivable tells you all the money your business is due to receive. Think of it as your best friend for knowing where your next dollar is coming from. A/R answers these key questions:

• Who owes you money?

• How much do they owe?

• When is the payment due?

• What is the payment for?

Staying on top of A/R means:

• Keeping track of the invoices you’ve sent—and those you haven’t.

• Managing estimates and job proposals.

If you’ve given customers a timeframe for payment upon completing a job, A/R gives you a clear view of upcoming cash inflows.

Accounts Payable (A/P): The Money You Owe

On the flip side, accounts payable tracks all the money your business needs to pay out. This includes:

• Bills you owe: Who you owe money to, how much, and what it’s for.

• Credit-based expenses: From subcontractor payments to software subscriptions like Microsoft 365.

A/P helps you manage expenses with set payment deadlines, keeping you in control of your financial obligations.

Focus on A/R and A/P Daily

You should spend about 70% of your time managing A/R and A/P. These two areas provide a clear view of your revenue and expenses that aren’t immediate, helping you better plan for the future.

Understanding the Bigger Picture

Once you’ve got a handle on your inflows (A/R) and outflows (A/P), it’s time to step back and get the full picture of your business finances. That means pulling together all the data from invoices, receipts, and emails—and analyzing it within the context of your financial statements.

The three key financial statements to understand are:

1. Income Statement (most critical for day-to-day operations).

2. Balance Sheet.

3. Cash Flow Statement.

How to Read an Income Statement

An income statement is the most essential financial document for your day-to-day business operations. It tells the story of your revenues, costs, and ultimately your profitability. Let’s break it down:

1. Revenues

The first line item is your revenues, which shows all the money your business brought in.

• Why it’s important: This figure helps you understand what generated income for your business.

• What to look for:

  • Compare revenue at the end of each month to the previous month. Are you growing or declining?

  • Break down your revenue by service type to see which services are the most profitable. For example, if bathroom renovations generate more profit than kitchen makeovers, you’ll know where to shift your focus.

Lets take a look.

Although this sample company is not very descriptive in their services and products you can see how they make loads of their income from bathroom renos and new construction builds. Softwares like quickbooks can break this information down even further by project, this income statement you see is just a snapshot breakdown of each service.

(example of QBO profit and loss by class beauty)

2. Cost of Goods Sold (COGS)

The next critical figure is your cost of goods sold, which tells you how much it cost to produce your service or product.

• What’s included in COGS:

  • Raw materials: The wood for a flooring job or paint for a renovation.

  • Direct labor: Subcontractors or employees directly tied to completing the job.

  • Job-specific overhead: Equipment rentals, consumables, or other expenses tied to delivering that service.

• Why it’s important:

  • COGS determines how much cash you have left to run your business after providing your core services.

  • It shows whether your pricing is appropriate—if COGS is eating up most of your revenue, your prices are likely too low.

• Direct vs. Indirect Costs:

  • Direct costs: Expenses directly tied to producing the service, like materials and labor.

  • Indirect costs: Expenses not tied to specific jobs, like depreciation or insurance, which are useful for offsetting taxable income.

Example: If you can tell how much wood was used on a flooring job, that’s a direct cost. But the insurance cost for the worker doing the flooring? That’s indirect.

Once again let's take a look.

I know we haven't gotten to net income but you can already see how important it is to keep track of every expense that goes into producing each project as without it you would not be able to generate data like this which shows you how much your COGS is or isn't eating into your profits. Here the COGS is 47.05% almost half of your sales!

3. Gross Profit

Gross profit is what you’re left with after subtracting COGS from your revenues. It’s the money you have to cover operating expenses.

• Gross Profit Margin: Gross Profit ÷ Revenue, expressed as a percentage of your sales.

Example: If your gross profit margin is 15%, it means 85% of your revenue went into COGS.

• Imagine a $10,000 bathroom renovation where $8,200 goes to COGS. That leaves you with just $1,800. Multiply that by three jobs a month for a year, and you’re left with $64,800/year. Sounds decent, right? But when you add operating expenses like insurance or loan repayments, it’ll feel like you’re barely breaking even.

Key takeaway: Low gross profit margins mean you need to revisit your pricing or control your COGS more effectively.

This company has got a 52% profit margin which means their pricing is on point they just need to manage their operating costs.

4. Operating Expenses

Operating expenses are the costs incurred to run your business and sell your services.

• Examples of operating expenses for contractors:

  • Fixed costs: Lease payments, insurance.

  • Variable costs: Marketing spend, tool rentals, bookkeeping fees (yes, shameless plug!).

• Why it’s important: These expenses need to be tracked carefully to avoid overspending, especially on variable costs like ad spend, which can fluctuate month to month.

Finally, the good stuff. Let's take a look.

This income statement is just for the month so youre missing things like sales tax, income tax, depreciation and other annual adjusted expenses that dont get added on until the end of the year or quarter.

However you can see how just looking at the money brough in by your services is not enough to tell you if the business is truly making money. 85k in revenue to make 19.8k, still missing taxes.

5. Net Income

This is the bottom line—the money left after all expenses are subtracted from revenue.

• Why it matters: This is your "take-home" profit, and it’s up to you how to use it:

  • Reinvest in your business.

  • Pay yourself.

  • Save for future growth or taxes.

Now looking at your gross profit and net income should tell you if you want to grow those numbers or maintain them. The better you manage your books the more options you'll have.

TLDR

Key Bookkeeping Terms Every Business Owner Should Know

• Accounting Period: The time frame (e.g., monthly, quarterly) for which financial reports are prepared.

• Income Statement: A summary of revenues, expenses, and profit over an accounting period.

• Balance Sheet: A snapshot of your business’s financial position, showing assets, liabilities, and equity.

• Assets: What your business owns (e.g., cash, equipment, inventory).

• Liabilities: What your business owes (e.g., loans, unpaid bills).

• Owner’s Draw: Money taken out of the business for personal use.

• Accounts Receivable (A/R): Money owed to your business by clients.

• Accounts Payable (A/P): Money your business owes to suppliers or creditors.

• Source Documents: Original records like invoices, receipts, and bank statements used for bookkeeping.

• General Ledger: The main record of all financial transactions.

• Reconciliation: The process of ensuring your books match your bank records.

• Purchase Order: A document issued to order goods or services from a vendor.

• Estimate: A preliminary calculation of the cost of a project or job.

• HST (Harmonized Sales Tax): The sales tax applied in Ontario and other provinces.

• Taxable Sales: Revenue that is subject to sales tax.

• Gross Profit: Revenue minus the cost of goods sold (COGS); measures profitability.

That's the End.

There’s also the cash flow statement you should be looking at, but I’ll break that down in another post.

In essence, from start to finish, these are the most basic things about your bookkeeping that you need to understand. Without them, you could be bringing in lots of revenue but not making any real profit or net income.

Stay tuned for my next blog, where I’ll break down the cash flow statement and why it’s crucial for long-term business success.